The One Big Beautiful Bill Act (OBBBA) brought a lot of new changes when it was enacted in July. One of those changes alters how tip income and overtime income are taxed. Prior to the OBBBA, tip income and overtime income were fully taxable for federal income tax purposes. Now, you may be eligible for tax deductions on your tip and overtime income.
Tip Income Tax Deduction
For 2025–2028, the OBBBA creates a new temporary federal income tax deduction that can offset up to $25,000 of annual qualified tip income. It begins to phase out when modified adjusted gross income (MAGI) is more than $150,000 ($300,000 for married joint filers).
Tip Income Tax Deductions are available if a worker receives qualified tips in an occupation that’s designated by the IRS as one where tips are customary. However, the U.S. Treasury Department recently released a draft list of occupations it proposes to receive the tax break and there are some surprising jobs on the list, including plumbers, electricians, home heating/air conditioning mechanics and installers, digital content creators, and home movers.
Employees and self-employed individuals who work in certain trades or businesses are ineligible for the tip deduction. These include health, law, accounting, financial services, investment management, and more.
Qualified tips can be paid by customers in cash or with credit cards or given to workers through tip-sharing arrangements. The deduction can be claimed whether the worker itemizes or not.
Overtime Income Tax Deduction
For 2025–2028, the OBBBA creates another new federal income tax deduction that can offset up to $12,500 of qualified overtime income each year or up to $25,000 for a married joint-filer. It begins to phase out when MAGI is more than $150,000 ($300,000 for married joint filers). The limited overtime deduction can be claimed whether or not workers itemize deductions on their tax returns.
Qualified overtime income means overtime compensation paid to a worker as mandated under Section 7 of the Fair Labor Standards Act (FLSA). It requires time-and-a-half overtime pay except for certain exempt workers. If a worker earns time-and-a-half for overtime, only the extra half constitutes qualified overtime income.
Qualified overtime income doesn’t include overtime premiums that aren’t required by Section 7 of the FLSA, such as overtime premiums required under state laws or overtime premiums pursuant to contracts such as union-negotiated collective bargaining agreements. Qualified overtime income also doesn’t include any tip income.
Payroll Tax Implications
While you may have heard the new tax breaks described as “no tax on tips” and “no tax on overtime,” they’re actually limited, temporary federal income tax deductions as opposed to income exclusions. Therefore, income tax may apply to some of your wages and federal payroll taxes still apply to qualified tip income and qualified overtime income. In addition, applicable federal income tax withholding rules still apply. And tip income and overtime income may still be fully taxable for state and local income tax purposes.
The real issue for employers and payroll management firms is reporting qualified tip income and qualified overtime income amounts so eligible workers can claim their rightful federal income tax deductions.
Reporting Details
The tip income tax deduction is available for both employees and self-employed individuals. Qualified tip income amounts must be reported on Form W-2, Form 1099-NEC, or another specified information return or statement that’s furnished to both the worker and the IRS.
Qualified overtime income amounts must be reported to workers on Form W-2 or another specified information return or statement that’s furnished to both the worker and the IRS.
IRS Announcement About Information Returns & Withholding Tables
On November 5, 2025, the Treasury and IRS issued Notice 2025-62 granting transition penalty relief for tax year 2025. Employers and other payors will not be penalized in 2025 if they are unable to separately report qualified cash tips (and related occupation codes) or qualified overtime compensation on Forms W-2, 1099-NEC, or other information returns. The IRS is treating 2025 as a transition year because forms and systems were not updated mid-year.
Important: this relief applies only to penalties for missing the new separate-accounting fields. Employers must still file/furnish otherwise complete and correct W-2/1099 forms, and they are strongly encouraged to provide employees/payees with the qualified tip and qualified overtime totals by another method (for example, an online portal or supplemental written statement). This separate data will help workers determine eligibility and claim the new deductions on their 2025 tax returns. Forms are expected to be updated for 2026 reporting.
Employers and payroll management firms are advised to begin tracking qualified tip income tax deduction and qualified overtime income tax deduction immediately and to implement procedures to retroactively track qualified tip and qualified overtime income amounts that were paid before July 4, 2025, when the OBBBA became law. The IRS is expected to provide transition relief for tax year 2025 and update forms for tax year 2026. Contact us with any questions.
